Speculators Smash Gold as Dollar Squeeze Tightens
Comment of the Day

July 22 2015

Commentary by David Fuller

Speculators Smash Gold as Dollar Squeeze Tightens

Here is the opening of this interesting column by Ambrose Evans-Pritchard for the Daily Telegraph:

Powerful speculators have launched an unprecedented attack on the world gold market, driving prices to a five-year low as commodities wilt and the US Federal Reserve prepares to tighten monetary policy.

Spot prices slumped by more than 4pc to $1,086 an ounce in overnight trading after anonymous funds sold 57 tonnes of gold in Shanghai and New York, choosing the moment of minimum market liquidity in what appears to have been a synchronized strike intended to smash confidence.

Spot prices slumped by more than 4pc to $1,086 an ounce in overnight trading after anonymous funds sold 57 tonnes of gold in Shanghai and New York, choosing the moment of minimum market liquidity in what appears to have been a synchronized strike intended to smash confidence.

Ross Norman, a veteran gold analyst at brokers Sharps Pixley, said sellers dumped 7,600 contracts covering 24 tonnes on the Globex exchange in New York in a two-minute span after it opened late on Sunday night.

A further 33 tonnes were sold at almost exactly the same time in Shanghai. The combined hit of 57 tonnes in such a short period is an extraordinary event in the world’s relatively small gold market.

“They choose the optimal moment in the early morning and when Japan was closed for a holiday to get the biggest bang for the buck. It was clearly ‘short’ traders using leverage to trigger (technical) stops,” he said.

The price later regained some of its ground, allegedly as the profiteers cashed in jackpot gains on options that they also had. “It was a trade within a trade,” said Mr Norman.

The slide came as the Bloomberg commodity index hit a 13-year low, dragged down by the slump in base metals and energy. Gold has fared better than other commodities over recent months - trading on its safe-haven status during the Greek crisis and China’s equity crash - but it now risks being sucked into the vortex as well.

Michael Lewis, commodities chief at Deutsche Bank, said the “fair value” for gold is around $750. This is based on an index of eight indicators, such as oil, copper, income per capita and equity prices, that dates back to the early 1970s. Gold tends to “mean revert” over time.

David Fuller's view

Here is a PDF of The Telegraph article.

The latest bear raid for gold described above is fascinating.  The simultaneous selling of 57 tonnes, of which 24 tonnes were on the Globex exchange in New York, and 33 tonnes in Shanghai, was a massively well organised raid. 

Moreover, in China’s command economy, I assume that the Shanghai sale could not have occurred without government knowledge and probable participation.  This is very likely because the sale came shortly after China’s central bank issued the suspect and bearish figure of 1,658 tonnes in bullion reserves. 

China’s monetary authorities knew what they were doing.  Additionally, they almost certainly knew about the Soviet Union’s purchases of gold before military invasions.  The one I remember best was their invasion of Afghanistan in late December 1979.  There had been a flurry of gold buying a few days beforehand.  Around 6:30am I was running up Queens Gate towards Hyde Park, to join a few Thames Hare & Hounds colleagues for our morning circuit. As I passed the normally quiet Bulgarian Embassy at 186-188 Queens Gate, I was surprised to see several limousines parked in front.  Later in the day, I heard reports detailing the invasion of Afghanistan as the reason why gold had rallied strongly.  The Russians presumably sold their additional gold a few days later to finance this nefarious action.  Veteran subscribers may recall my comments on this story at the time.   

I do not think China is planning to invade another country this month, but if they were, they would be much more likely to buy gold.  So why did China sell gold aggressively recently?

They may need the money, although this seems unlikely to me.  However, China may wish to push the price lower, so that they can buy more gold and perhaps even distressed gold mines with good reserves.  However, this is conjecture on my part, so I welcome any informed feedback from subscribers, in the days, weeks or months ahead. 

More importantly, where is gold going over the medium to longer term?  In addressing this question, I am annoyed with myself for not always maintaining a long-term perspective with gold and silver, especially as they had been my most successful trading vehicles over the decade up to their 2011 peaks. I know a number of veteran subscribers also did very well in these two metals over the same period. 

However, if we are not very good at controlling our emotions, not least after a good run, we are unlikely to have the objectivity to understand what follows.  This is particularly true if we are looking at mainly short-term charts, which may be useful for trading, but not big picture perspective.   

Therefore, in considering the medium to longer-term outlook for gold, let us look at this semi-log 50-year picture, and also this arithmetic graph over the same period.  They have somewhat different but complementary strengths.

This is not a chart course so I will not go into too much detail in trying to answer the primary question concerning gold’s long-term outlook.  However, the semi-log chart is often more helpful for big picture perspective, but may impede top formation recognition by condensing data and desensitising one’s perceptions regarding trend change.  Also, semi-log will show equal percentage changes but at the cost of disguising numerical accelerations which are important features of may big bull market peaks.

Looking first at the semi-log chart above, the 1980 peak was so explosive that it clearly did accelerate in 1979 and early-1980.  However, it condensed the 2011 acceleration, causing me to conclude from this chart that we might only see a medium-term correction, similar to the 2006 and 2008 reactions. 

Incidentally, silver (semi-log & arithmetic) had the spectacular runaway bull trend and was a very useful lead indicator.  One gains perspective by following a closely related sector, such as precious metals, and the higher beta instruments will usually lead at tops and bottoms. 

Looking at the 50-year arithmetic chart of gold above, you can clearly see that there was a numerical acceleration at gold’s 2011 peak. 

Now let us consider influences on the gold market.  The key point, I suggest, is that gold does not move in isolation. Instead, it attracts haven support when stock markets (gold shares excepted) and the US Dollar are less appealing, and inflation is rising.  Gold’s last two big bull markets, in which there were no central bank restrictions on buying or selling this monetary metal, occurred during lengthy valuation contraction cycles on Wall Street, sometimes referred to as secular bear markets.

In other words, the Dow Jones Industrial Average effectively had a glass ceiling near 1040 from the mid-1960s through 1980.  Additionally, US Treasury Bond yields were soaring on inflationary expectations.  The Dollar Index slumped from 1971 until completing a small base in 1980.  Without any competition from stock markets or the Dollar Index, in terms of price action, gold soared. 

In 2000, the US stock market ended a secular bull trend and commenced a lengthy valuation contraction cycle, particularly during the two severe bear markets commencing in 2000 and 2008.  Moreover, many financial commentators were forecasting further crashes for several more years.  T-Bond yields ranged for nearly six years.  Once again, this was a favourable environment for gold, since the US stock market was not trusted and T-bonds were neutral. Better still, the Dollar Index’s moves were mostly favourable for gold.  Bullion began to recover as DXY commenced a slump in 2002, punctuated by a partial upside retracement in 2005, which temporarily tripped gold with a delayed reaction in 2006.  DXY’s rally from a low in 2008 produced another medium-term correction in gold.  Lastly, DXY’s rally following a successful test of its low in 2011 coincided with gold’s peak. 

Armed with this information, what does Fuller Treacy Money anticipate over the next decade or two, and how would that affect gold?

1) We maintain that there is a strong case for a secular bull market in equities, propelled by accelerated technological innovation, which is leading to lower energy prices.  Both factors will help GDP growth to recover in the next few years.  Corporate profits will benefit additionally from globalisation among mostly capitalistic economies, plus rapidly increasing middle classes in developing counties. 

2) The prospect of global economic recover has already put a floor under government bond yields.  They may mostly range for the lengthy medium term, before GDP growth recovers.  Moreover, inflationary pressures remain low due to globalisation and technological innovation, including robotics.  Nevertheless, the path of least resistance will be sideways to somewhat higher, particularly when the global economy is stronger. 

3) We also maintain that the Dollar Index has clearly ended its secular bear market.  Therefore, it has only seen the first leg of a new bull trend.  A gradual long-term recovery in the Dollar will be supported by the USA’s technology lead, including the ability to produce most of the energy it requires, and the competitive strength of its many corporate Autonomies.  

This is not a favourable background for gold.  In particular, we have seen how a secular bull trend for US equities and many other stock markets considerably reduces the appeal of gold as a safe haven.  A firm US Dollar is a proven headwind for bullion’s price in terms of the world’s most important reserve currency.  However, as a monetary metal gold will appreciate against weaker currencies. Gold does rise with bond yields in response to inflationary pressures.  However, this is not a concern today, especially as technology is creating positive deflation.

Gold has reaffirmed its bear market in US Dollar terms.  Its previous bearish cycle between 1980 and 2001 is an approximation of what could take place.  Inevitably, persistent declines will be followed by technical rallies, a few of which will be significant, as we saw from mid-1982 and more persistently from 1985 through 1987.  It could be many years before gold retests and exceeds its 2011 high in another bull market.  Lastly and most importantly, preconditions for the next gold bull market in US Dollar terms are persistent weakness in both the US stock market and the Dollar Index.    

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